Escape from the Ivory Tower: Obscure Academic Economic Concepts Worth Knowing
In econ grad school, you learn a dozen good ideas and a hundred seemingly irrelevant ones. Most of those hundred ideas deservedly languish in obscurity; no one uses them to explain the real world, even in conversation. But once in a while, you realize that one of those obscure concepts is genuinely enlightening.
Trembling hands perfection is my favorite example. A typical explanation:
A trembling hand perfect equilibrium is an equilibrium that takes the
possibility of off-the-equilibrium play into account by assuming that
the players, through a “slip of the hand” or tremble, may choose unintended strategies, albeit with negligible probability.
When first described, the concept seems like a mere make-work project for game theorists. But I’ve gradually noticed that it’s a big deal. It explains, for example, why imposing harsh punishments for small infractions isn’t nearly as smart as it seems: People sometimes accidentally break the rules. Automatically imposing harsh punishments imposes needless costs on well-meaning people, and gives incentives to avoid valuable actions with above-average accident rates. In a noisy world, forgiveness and second chances are common sense, not sentimental folly.
The trembling hands concept also explains the value of trying to exceed others’ expectations. In the real world, it’s not smart to apply the minimum acceptable level of effort, or pay others the smallest amount you can get away with. Accidents happen – and if you cut everything close, those accidents will have needlessly bad consequences.
OK, that’s my nominee. My challenge for other econ bloggers: Name yours. What’s your favorite obscure-but-genuinely-enlightening academic economic concept?